Boost your Profit - Your step-by-step guide to small development

Gone are the days when developing property was available only to multimillionaires and high-rollers. These days anyone with a bit of savvy and some investment experience can become a successful property developer, but it is not for the faint of heart. Nikki Taylor explains

In this three-part series, Your Investment Property will tell you everything you need to know about making the transition from property investor to property developer. In Part One of the series we will explore the first steps you need to take on the road to becoming a property developer. These include:

How much money you’ll need to get started

How much research you should do

Planning your exit strategy

Gathering your team of experts

So let’s get started…

Part One – Breaking ground
To be a successful property developer you need three qualities: vision, determination and guts. It is not an easy road, but developing property can be very rewarding – not just financially, but creatively as well. Seeing your vision come to life, brick by brick, tile by tile, can be incredibly inspiring, and the goal at the end is to achieve a very healthy profit.

Gavin Taylor, a director of Metropole Projects, says becoming a property developer is akin to being a movie producer.

“Successful property developers are a bit like movie producers,” he explains. “They assemble a highly talented team of people and skilfully lead them to develop a profitable outcome. Developers need to be proactive and make things happen. They must also be creative, flexible and adaptive to take their project through the development maze, not to mention all of the bureaucratic red tape that’s involved with council applications, zoning restrictions and the like.”

Taylor says you also should not overlook the importance of hard work and focus. “As a developer, you need to work hard, have patience, remain focused, and have a burning determination to succeed.”

So do you have what it takes to be a developer? Before you begin, ask yourself these questions:

Is this what I really want to do?

Do I have enough experience in property investing?

Financially, can I take on any unexpected expenses?

Do I feel emotionally able to deal with stressful situations?

Am I time poor, or can I commit my time to this project?

Have I done enough research?

Do I know who I need to help me?

Is my partner, family, support base on board?

Am I sure the reward at the end will be worth the effort?

If the answer is yes, the next question you need to ask is: ‘How much money will I need?’
While some lenders are prepared to offer up to 95% of the purchase cost for an existing residential dwelling, a potential developer who is building three or more units can usually expect a different set of requirements from lenders.

Andrew West, sales manager at Global Capital Commercial, a Sydney-based brokerage company specialising in development and investor finance, says potential property developers should first weigh up the pros and cons of using either a private or bank lender, as requirements can vary greatly between the two.

“You’ve got mainstream lenders like banks, and then you’ve got private lenders, and there are strengths and weaknesses to both,” he explains. “With banks, typically you are looking at being able to borrow anywhere up to 80% of the cost, as long as that doesn’t exceed 65% of the Gross Value (GRV), or total value rate at time of completion, excluding GST.” He says banks will generally require a level of presales for comfort, meaning 60– 100% of the debt has to be covered, and most loans will incur an interest rate of around 5.5% as well as an application fee. So if a developer already has the presales in place, this is definitely the cheapest option available.

“This means in a rising market the developer needs to sell units upfront before he can commence construction, all with 10% deposits, completed at today’s value, and probably discounted because people can’t see what they’re buying,” West explains.

“You also have to be able to provide full financials for the banks.” West says private lenders, on the other hand, will take a view of the property and not require presales or financials, but the interest rates will be significantly higher – often more than double those of traditional lenders.

“When you’re buying a single property the interest rate is all-important, but development is a commercial transaction where interest and costs are consolidated and revenue is the sales of those properties.

“So if you take the bank’s position with cheaper interest rates where you’re selling to cover 60– 100% of the debt, you’re probably looking in a rising market of a discount of 5–10% on what the sale price will be in the future, so many developers will take the higher interest rate because the upside in a rising market means extra profit in the developer’s pocket.”

For investors looking to make the transition into property development, West says a good rule of thumb is to have 30% existing equity for the project.

“If you can own the land outright you probably have very strong chance of getting a deal across the line without the need for presales,” he says.

Matthew Flegler, general manager of Queensland company FARM Developments, has completed eight developments, with a combined value of more than $28m, and agrees with West’s rule of thumb.

“When I’m working it out I apply 50% of the land cost as cash that I need put into the project. I always try to put less in, but it’s best to work on the worst-case scenario and try and improve the position from there,” he says.

The simple answer to this is: as much as you can
When it comes to property development and subdivision, there are a number of factors to consider that almost never come into play when investing in existing dwellings. Property investment coach and director of the RESULTS Mentoring Program Brendan Kelly advises that, once a land parcel is identified, there are five main points potential investors need to consider before making any offers:

1. Dial Before you Dig
Critically, you need to know where any services lie on your block. It’s not uncommon to have an easement containing sewer pipes running through the middle of a block. If you’re not aware of this, you’ll get a nasty surprise when the council rejects your application to build over the easement, or there’s an additional cost to relocate it around the boundary. Dial Before You Dig can be accessed at www.1100.com.au.

2. The topography
If the slope is great, costs to build will soar. If the slope is down and away from the street, and if the storm water drains are on the street, then you’ll need to access the stormwater legal point of discharge (drain) through the neighbour’s house, and this may not be possible. If you cannot visit the property, Brendan says using Google Street View maps provides a broad perspective of whether the block is flat or sloping. If it is possible to see the land in person, he says it is wise to assess whether the back fence is more than hip height higher or more than a metre and a half lower than where you are standing, and it is best to use the Dial Before You Dig service and to contact the local council’s development department and check the easements. It also wise to check the location of storm water points of discharge and sewerage outlets, because as we all know, ‘fluid’ doesn’t run uphill.

3. The title and the boundaries
Ensure that the land size you are looking at buying is the size given in the advertisements, particularly the size of the street frontage. In many cases, there are significant building restrictions for narrow blocks with small street frontages. Brendan recommends taking a tape measure to the inspection, if possible, and double checking the document of sale and the vendor’s statement. It is most important to check the location of easements, as should one be running through the middle of the land, development will be impossible.

4. The council
Every council has its own planning departments and guidelines. While they adhere to the state-based planning requirements, each council has its own interpretation of those guidelines. It is important to know what restrictions exist for building on that block or, if you plan to subdivide, then what needs to be satisfied to get the process through council smoothly. Rocking the boat with the council increases the costs of the project and can significantly erode profitability. Brendan says this information is available from the local council’s Department of Planning.

5. Consider overlays
(Reports are available from the local council’s Department of Planning.)

Environmental
It may be that you can’t remove significant trees and therefore you can’t build that second dwelling.

Heritage
Your proposed development may have some local heritage value for the community, restricting your ability to develop it in the way you want to.

Indigenous
Check for overlays that govern the sensitivity of historic land sites for indigenous Australians and restrict activity, including subdivision and building, on the site.

Flood
zones In flood zones requirements can be severely restricted by accommodating the risk of the 100-year flood.

Once your five land points are covered, Flegler believes it is a good idea to make a checklist of questions about your project to see if it fits in with the surrounding area. He suggests answering these questions before making an offer on any land:

Is this development going to work in the area, and is there a need for it?

Is this an area I would like to live in and raise my family in?

What are the building costs in the area?

What are the sales estimates from agents?

While all these points are critical to achieving development success, Flegler says one of the most important aspects of your research is to calculate how much you can afford to spend on the land. “Remember you make money on the purchase, never the sale at the end. It’s about buying right,” he warns. “A good rule of thumb is to double the time agents say it will take to sell it and decrease their estimates by 10% to 20%.Then work backwards from your end sales figures; work out conservatively what the construction costs will be, including all the ‘extras’. “Work out what you want for profit, and only then will the amount you can afford to pay for land be revealed.”

Do I need to plan my exit strategy before I start?‘By failing to prepare, you are preparing to fail’ – Benjamin Franklin

Benjamin Franklin understood the importance of making a plan, and so should any potential property developer. By knowing what you want to achieve before you start, you are in the best position to accomplish your goal, whether that is adding to your portfolio or realising further investment capital.

According to founder of Property Collectives and investor Tim Riley, pre-planning an exit strategy is an important aspect of achieving success as a property developer. “When you get into development you need to have the exit strategy in mind, and that will vary based on what type of developer you are,” he says. “A good way to decide is by asking yourself, why am I doing this? Am I doing this to build up a portfolio of assets or am I looking to build more capital for the next project?” However, Riley believes that for first-timers the best way forward is to take one development project at a time before jumping too far ahead. “If you’re a first-timer, you might plan to continue developing only to find it is too stressful and your intentions may change,” he explains. “You can plan out where you want to go in the longer term, but each project is different and it is best to work on each project specifically as you go.” Likewise, Flegler says he always plans his exit strategy before beginning a project. “When I’m looking at a potential project I need to see and understand the exit strategy,” he says. “If the exit strategy is sound and achievable, then I will look further into the project.”

So how do you create your exit strategy?
According to Flegler, the first step in creating a solid exit strategy is to start by doing a significant amount of market research prior to purchase. “You need to find a real estate agent that will work with you, really with you, and it’s not easy,” he says.

“You need to meet with at least three, preferably one who is not local, to get a real true idea of the market for your development. Once I decide on an agency I deal directly with the principal because they are the ones who understand the market better than anyone.”

He says understanding the viability of your product in the current market is crucial to the success of your exit strategy and project. “If your agent gives you a report saying each dwelling in your development will be worth around $500,000, and market research shows previous sales of properties sold around that value are few and far between, then your exit strategy isn’t viable. You need to know the development is competitive and within market value.”

The same is true for developers looking to use a buy and hold strategy. If the rental amount is overpriced for the local market, vacancy rates will become an issue. Flegler believes all exit strategies should also include a marketing plan, and a good rule of thumb is to allow 1% of the end sale price, on top of agent commission. He says agents usually include a certain amount of advertising as part of the proposal, but paying for additional marketing material like signs and online advertising is crucial. “At least 80% of my enquiries come from online and in a slow market I would allow 1% for marketing, maybe even 0.5%.”

What kinds of professionals do I need to help me get sta rted?

Fast facts What my development team might look like:

Real estate agent

Lawyer/legal advisor

Town planner

Financier

Building contractor

Project manager

All projects are different and will require different teams, but there are a few staple professionals that every potential developer should have on their team. After completing $28m worth of projects, Flegler is an experienced property developer but says he still understands the importance of consulting experts when it comes to legalities, accounting and management. “Employ a good project manager and have a good property-focused accountant and solicitor,” he advises. “Also, find a good development finance broker who will hold your hand right through to the exit of the project, and who is also willing to go in to bat for you with the bank should things not go according to plan. “What other advisors you need will depend on the type of project – they could be town planners, surveyors, engineers, architects, builders, quantity surveyors.”

Likewise, Riley believes having a mentor who has been through the process, with a successful outcome, can be invaluable. “Depending on the scale of the project you’re working on, it’s really important to have someone there who’s done it before and knows the ropes. That can be either a friend, a contact who has done developments themselves, a developer, a good architect who can help you through the planning, or a project manager to help you through the construction phase.” He also suggests contacting a network of professionals who are happy to help beginners. “There are a few people around who do this, and there are providers out there who offer a mentoring service,” he explains. “The other option is to join groups on LinkedIn where there are a number of development groups set up for different places like Melbourne and Sydney, or you can attend networking events in your area.”

Taking a closer look at your team a nd why you need them

Project manager
For beginners, using the experience of a professional project manager can go a long way in ensuring the success of your project. A project manager will take on practically all the day-to-day responsibilities of your project, from overseeing construction to liaising with your team of advisors. But remember, no one understands your goals better than the developer, so while a project manager can be instrumental, they will never be you.

What is a project manager responsible for? - Every aspect of the project, from conception through to completion, hiring to negotiating, and overseeing the build and on-site OHS.

Where do I go to find one? - General market media – Google, trade directories, LinkedIn groups, word of mouth.

How do I evaluate them? - Ask to see what projects they have completed and if you can talk to any of their clients.

How much should I pay? - An average salary is about $2,000 per week, but most will quote based on the project.

Importance rating out of 10: For first-timers – 10.

Builder
Without a builder your project will never be more than an image in your mind. All land parcels are different, and your project is just that – yours, which makes it unique. A builder needs to be able to consider your development from an individual perspective and work well with the rest of the team to see your dream come to fruition.

What is a builder responsible for?

Facilitating various trades in a construction project.

Where do I go to find one?

General market media – Google, trade directories, Yellow Pages.

How do I evaluate them?

Check their licence with the state governing authority.

How much should I pay?
This depends on the building quality and timeframe. Should you be unsure, check rates or quotes by obtaining multiple quotes, or engage the services of a quantity surveyor.

Importance rating out of 10:

If starting out, then 10 – but more experienced developers generally end up becoming the builder.

Lawyer/legal advisor
A development project requires cutting your way through a lot of red tape, and gathering, signing and delivering an exhaustive list of documents. A lawyer who is knowledgeable in development and town planning can advise you along the way and is a solid asset. They can also draw up documents and contracts required during the development process.

What is a lawyer responsible for? - Administrating the terms and conditions of purchase or sale contracts, advising on legal issues, drawing up contracts. They can also can be responsible for corporate risk strategy to mitigate legal exposure.

Where do I go to find one? -General market media; ask other developers.

How do I evaluate them? -How well do they understand property and corporate law?

How much should I pay? - Rates are generally in accordance with state law societies.

Importance rating out of 10: 10

Accountant
Making a profit is the main point of developing, so you need a professional in your corner who knows the ropes. An accountant will ensure you are setting up the correct structure for maximum profitability. Minimising tax liabilities and maintaining the operating budget of your project will also come under the job description of your accountant.

Where do I go to find one? - General market media; ask other developers.

How do I evaluate them? - Do they specialise in property investment? Do they invest in property themselves? How many properties do they have?

How much should I pay? - $200+ for an annual tax return and $100–$500 for a tax planning session.

Importance rating out of 10: 10+

Finance broker
There are not many potential developers out there who won’t need at least some finance for their project. Achieving finance for a development project is different than financing the purchase of a dwelling, so choosing a broker who understands the process is crucial to getting your plans across the line.

What is a finance broker responsible for? - Homelands, property valuations, getting you access to finance, going to bat for you against the people with the money.

Where do I go to find one? - General market media; ask other developers.

How do I evaluate them? - What percentage of their clients are investors? Do they specialise in property investment? Do they invest in property themselves? How many properties do they have?

How much should I pay? - $0 – most brokers are paid a trailing commission by the lender.

Importance rating out of 10: 8

Real estate agent
A solid and reliable real estate agent should be one of the first cabs off the rank when you begin your development process. An agent with knowledge of the area can provide you with feedback on the viability of your project, the design, the local market and sales prices. They will also be responsible for selling or letting your completed project, so ensure they have experience with your type of dwelling.

What is a real estate agent responsible for? - Advising on the viability of your design, giving feedback on the local market, advising of sales times, selling or renting your properties on completion.

Where do I go to find one? - Google, Yellow Pages; walk around the local area of your project. Get at least three opinions before you choose someone, ideally two local and one out of area.

How do I evaluate them? - What is their sales record like? How many properties like yours have they sold? What is their local area knowledge?

How much should I pay: -Usually 2% plus GST.

Importance rating out of 10: 10+

Town planner
A town planner understands the planning regulations and can help you obtain the approvals and permits required to give your project the go-ahead. They need to be familiar with the relevant state and local government planning policies. They can also be instrumental in creating your application documents and proving the merit of your project with local government.

What is a town planner responsible for? - Advising on state and local government regulations; advising on application and approval documentation; going to bat for you with local government.

Where do I go to find one? - Google, Yellow Pages; in the local area of your project.

How do I evaluate them? - What is their approval record like? How many projects do they have under their belt? What is their knowledge of the local area and council?

How much should I pay: - About $2,000 – plus an hourly rate for any additional government negotiations.

Importance rating out of 10: 9

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